Share Class Offerings Shift With Fiduciary Focus

A focus on fairness and fiduciary fitness is driving many
investment product providers to implement R6 share classes and other
institutional offerings with zero revenue sharing.

Overall, according to the August 2015 issue of The Cerulli
Edge, nearly 60% of asset managers will make changes to share class offerings
heading into 2016. In this group, a
quarter plans to add share classes, “primarily cited as R6 or some zero revenue
share class,” and a similar number will move away from share classes that generate
revenue through commissions or sales fees.

The movement away from commissions and revenue sharing reflects
regulators’ focus on fiduciary care and conflicts of interest. In some
ways, Cerulli says the ongoing shift represents a return to a way of doing business
that was more popular 20 years ago, before investment managers started offering
an “alphabet soup” of different share classes.

Share classes diversified for a variety of reasons—partly because
of advancing recordkeeping technology and an interest among providers in
casting a wide net. Now the focus has shifted, Cerulli notes, and those paying
higher fees are demanding better service and a better deal.

It’s also a matter of competition. Keeping with the trend
toward low cost, flows “feverishly” moved into the cheapest share classes
during 2014, Cerulli says. Institutional share classes captured $165.5 billion of
inflows during the year, “eight times that of the next top-flowing share class
(Retirement). Looking at flows moving into newly introduced share classes, this
same trend continues.”

Cerulli’s findings come from an analysis of the 50 largest
asset managers, based on mutual fund assets under management as of year-end 2014.
At a high level, Cerulli says there appear to be “tiers of share classes among this
universe of firms.”

NEXT: Share class breakdown

The first tier includes institutional shares, A-shares,
retirement shares and C-shares.

“This first tier is offered by more than 70% of the top-50 firms,”
Cerulli finds. “Between 30% and 70% of firms also offer the second tier of
share classes, which includes no load, B-shares, R6, and an investor share
class.”

The third tier comprises an “amalgamation of share classes,”
Cerulli says, including adviser, S, N, D, T, and M. “These shares are offered by
less than 30% of the top-50 firms.”

Investment providers adding new products seem to be favoring
the first tier, as most newly introduced share classes were institutional (470)
and retirement (379) in 2014. According to Cerulli, A-shares and C-shares also
experienced triple-digit share class introductions.

“Flows for these new share classes were mostly in
institutional, accumulating $17.5 billion in 2014, representing 56% of total
net flows,” the report says. “Cerulli believes eventually there will be a
shake-out of share classes, leaving asset managers with just a few core share
classes—a low-cost institutional share class, a share class for retail
platforms (typically 40 basis points), a classic 25-basis-point 12b-1 share
class, and a bare-bones retirement share class.”

Another important theme highlighter for the retirement
market: plan sponsors are looking to separate the fund cost from the revenue “so
that the right individuals—and not necessarily the end investor—are paying.”

“Originally, the industry expected to see an increase in the
use of collective trusts for defined contribution (DC) plans in light of the
intense scrutiny around plan costs, but mutual fund providers responded by creating
either a zero-revenue-sharing share class, or a share class with embedded sub-TA
fees and zero 12b-1 fees,” Cerulli explains. “R-share class 12b-1 is designed
to cover compensation of an adviser or a third-party administrator of the plan.
Given the Department of Labor’s focus on fee disclosure and
transparency, the use of revenue sharing is generally on the decline.”

NEXT: Tough year so
far, across share classes

Cerulli finds that trends have shifted somewhat during 2015,
and increased favorability for transparent fee structures has not translated to
unbridled momentum for passive investments and the lowest-fee products. The
Cerulli analysis shows low-fee, passive institutional strategies experienced “significant
outflows in 2Q 2015.”

Outflows from passive products were strong enough for
Cerulli to declare that, while no one can know the future of asset flows, “the
framework of the active/passive debate will change from an either/or
proposition to how both approaches can be used in more customized,
objectives-based multi-asset-class strategies.”

Even before the most recent round of volatility spooked investors, the second half of
the year had kicked off on a sour note for mutual funds, according to Cerulli’s
research.

Mutual funds “bled nearly $11 billion during July,” dragging
the year to date inflow total down to $113.7 billion. Asset figures still increased
in July due to positive equity market movements, with mutual funds ending the
month up 0.1% at $12.5 trillion. Cerulli finds exchange-traded funds (ETFs) closed
July up 1.4%, reaching $2.1 trillion after a dip in June.